Economists frequently say that the firm plans in the long run and operates in the short run. Explain.
It is proven fact that the firm plans through the short run cost analysis for the long run analysis. As it is the long run cost curve that serves as a long run planning mechanism for the firm. As the long run period provides the firm with the time span to make all appropriate adjustments in its plant size to reach the least per unit cost at any given output.
According to the following figure:
[img alt_text=’planning-mechanism’ description=”]https://cdn.owlgen.com/wp-content/uploads/2019/10/planning-mechanism-min.png[/img]
Let’s say that the firm is operating at the SRAC 2 and it is currently producing an output of Q*, thus the firm’s average cost is C2. On the basis of the future demand projections the firm would expect to continue selling Q* units per period at the market price, however the profit would significantly increase with increase in the plant size to SRAC3. This means that the profit would increase by (C2-C1) * Q*. Thus it can be said that the firms profit maximization factor is based on the long run cost analysis based on increase or decrease in the plant size however, the current profits are based on the short run cost analysis.